Sukuk: Islamic Loophole for Dubai Debt Debacle
Islamic followers can be capitalists too. Although oil prices (currently around $77 per barrel) have fallen from the peak near $150 per barrel in 2008, oil rich nations have gotten creative in how they raise debt-like financing. Critical to fueling the speculative expansion in some oil rich areas has been the growth in sukuk bonds, which have been created as a function of an exploited loophole embedded in Islamic finance principles.
U.S. Does Not Have Monopoly on Debt Driven Greed
The pricked debt bubble that spanned a range of entities, from Icelandic banks to Donald Trump’s empire (read more), has now spread to Dubai commercial real estate. At the center of the storm is Dubai World, a quasi-government owned conglomerate of Dubai, which is in the process of negotiating a $26 billion debt restructuring with the government and sukuk bondholders. The overleveraged Dubai market ($80 billion in total debt) is home to the tallest building in the world, largest man-made islands, and a ski-resort based in the desert – all projects built with the help of debt in the face of collapsing real estate prices. Critical to Dubai World’s debt restructuring is a $3.5 billion sukuk bond issued by its commercial real estate subsidiary Nakheel Development (“Nakheel”). So what exactly is a sukuk (plural of sakk)?
Investopedia lists the following definition for sukuk:
“An Islamic financial certificate, similar to a bond in Western finance, that complies with Sharia, Islamic religious law. Because the traditional Western interest paying bond structure is not permissible, the issuer of a sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value.”
Sukuk “No-No”s
The generation of money on top of money – interest payments or what’s called “Riba” – is strictly forbidden by Shari’ah law. As a result, issuers must issue and repurchase sukuk at par (original value), not at a discount or a premium. Shari’ah law encompasses more than Islamic law, it also covers the amorphous spiritual and moral obligations demanded from the religious practitioners. In order to ensure compliance with Islamic principles, many financial institutions and funds typically have a Shari’ah Board monitoring the details of the sukuk. Shari’ah law is very consistent with the teachings in the Quran (the Western version of the Bible). Mixing finance and religion may seem strange on the surface, but I guess if we use world history as a proxy, we shouldn’t be surprised that money and Muhammad somehow find a way to coexist.
Click Here to View CNBC Interview on Sukuk Bonds
Sukuk Structure & Market
The core Islamic finance principles underpinning the sukuk market have been around for more than 1,500 years, but the actual sukuk market was actually introduced in Malaysia around 1990. Since then, the market has been on a continual uptrend. What makes this $1 trillion Islamic debt market (HSBC estimate) even fuzzier is the scores of sukuk structures (See Ijara Sukuk chart below – very similar to a sale-leaseback arrangement), and the diverse geographic issuer/investor base. For example, greater than 60% of Nakheel’s investors are based outside the Middle East (a large portion in Malaysia). Making matters as clear as mud, each geographic region and structure has its own interpretation of legal rights and Shari’ah law. Layer on issues such as derivatives, bankruptcy rights, and penalty fees and you end up with only more complexity. What’s more, many of these sukuk bonds involve Special Purpose Vehicles (SPVs) – made famous by the off-balance sheet variety used by Enron Corp. – in order to get around the Islamic issuance loopholes.
Source: Moody's Investor Service
Sukuk Liquidity
The illiquidity of sukuk market hasn’t made resolving the Dubai debt restructuring any easier. The sukuk market doesn’t come close to matching the liquidity of traditional corporate and sovereign debt markets. Little trading is done in secondary markets because most investors in sukuk bonds follow a buy and hold strategy. The lion’s share of trading in this immature market gets completed through inter-institution, over-the-counter transactions. A recent $500 million sukuk deal issued by General Electric (GE) last month has only raised awareness for the financing structure (pre-Nakheel restructuring). As oil rich states strive to diversify their economic bases, I would expect more deals to get done, in spite of the recent Dubai mess. How severe the recent Dubai sukuk black eye will be depends on how Nakheel, the United Arab Emirates (UAE), Abu Dhabi, bondholders, and other constituents restructure the pending sukuk obligations by the December 14th deadline.
The recent debt restructuring talks in Dubai highlight the complexity of this relatively new Islamic financing structure. With very few sukuk bankruptcy cases in existence, the structures remain largely untested and uncertain. How the Dubai debt debacle ultimately gets resolved will have a significant impact on this nascent, but rapidly growing market. Until the sukuk restructuring is settled, Dubai may just need to put the construction of that next man-made island on hold.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Information and data from Moody’s Investor Service (Shari’ah and Sukuk: A Moody’s Primer 5/31/2006), CNBC interview 12/2/09, Financial Times 12/1/09, and other articles. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in GE. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
More Eggs in Basket May Crack Portfolio
NOT putting all your eggs in one basket makes intuitive sense to many investors. Burton Malkiel, Princeton Professor, economist, and author, summed it up succinctly, “Diversity reduces adversity.” Diversification acts like shock absorbers on a car – it smoothens out the ride on a bumpy financial road (read more on diversification). Jason Zweig, Wall Street Journal writer, acknowledges the academic findings that underpin these diversification benefits by stating the following:
“As many studies have shown, at least 40% of the variability in returns can be reduced by moving from a single company to 20. Once a portfolio contains 20 or 30 stocks, adding more does little to damp the fluctuations in wealth over time.”
Despite the evidence, Jason Zweig explores the conventional views on diversification more closely.
Turning the Diversification Concept on its Head
Zweig, not satisfied with the standard thinking on the topic, decided to explore the work of Don Chance, a finance professor at the Louisiana State University business school. Professor Chance asked more than 200 students to consecutively select stocks until they each held a portfolio of 30 positions. Here are two of the main findings:
1) Averages Hold Firm: On average, for the group of students, diversifying from a single stock to 20 reduced portfolio risk by roughly 40% – just as would be expected from the academic research.
2) Individual Portfolios Riskier: After the first few initial stock picks, for each individual portfolio, were made from a list of large cap household names (e.g., XOM, SBUX, NKE), Professor Chance found in many instances students dramatically increased portfolio risk. These students juiced up the octane in their portfolios by venturing into much smaller, more volatile stock selections.
Deceiving Diversification
Gur Huberman, a Columbia Finance Professor also points out a tendency for investors to clump stock selections together in groups with similar risk profiles, thereby reducing diversification benefits. Diversifying from one banking stock to 20 banking stocks may actually do more damage. Statistically, Zweig points out, “Thirteen percent of the time, a 20-stock portfolio generated by computer will be riskier than a one-stock portfolio.”
Professor Chance found similar results according to Zweig:
“One in nine times, they [students] ended up with 30-stock portfolios that were riskier than the single company they had started with. For 23%, the final 30-stock basket fluctuated more than it had with only five stocks.”
Diversified Views on Diversification
Chance and Huberman are not the only professionals to question the benefits of diversification:
Warren Buffett: A diversification skeptic declares, “Put all your eggs in one basket and then watch that basket very carefully.” Alternatively, Buffett says, “Diversification is protection against ignorance.”
Peter Lynch: He referred to diversification as “deworsification,” especially when it came to companies diversifying into non-core businesses.
Charlie Munger: “Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.”
Zweig’s Solution:
“If you want to pick stocks directly, put 90% to 95% of your money in a total stock-market index fund. Put the rest in three to five stocks, at most, that you can follow closely and hold patiently. Beyond a handful, more companies may well leave you less diversified.”
Portfolio diversification and concentration have been issues studied for decades. As you can see, there are different viewpoints regarding the benefits. As Zweig establishes, through the research of Don Chance, putting more eggs in your basket may actually crack your portfolio, not protect it.
Read Complete WSJ Jason Zweig Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in XOM, SBUX, BRKA/B or NKE. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Economics and Consequences of Obesity
‘Tis the season to consume a lot of calories, and my tighter fitting, post turkey-day trousers can attest to that fact. Healthcare reform is front and center in the national debate, as well, and the rising epidemic of obesity should play a significant role in the discussion. Why is this issue so important? According to female financial guru, Suze Orman, we are already spending $57 billion more on obesity than cancer. Obesity-related health care costs totaled about $117 billion in 2000, according to the CDC (Center of Disease Control). One study on obesity estimates the problem will cost the United States $344 billion in health costs by 2018.
Although it may be an uncomfortable issue to talk about, this matter has had a direct personal impact on my family, making the problem all the more tangible to me. Regardless of the function of genetics or what lifestyle choices are made, the negative consequences are indisputable.
Take a look at the table of negative outcomes provided by the CDC:
These consequences obviously take a large toll on the individuals, but they also have a massive impact on our healthcare system. And the CDC has the data to backup the severity of this intensifying problem:
“More than one third of U.S. adults—more than 72 million people—and 16% of U.S. children are obese. Since 1980, obesity rates for adults have doubled and rates for children have tripled. Obesity rates among all groups in society—irrespective of age, sex, race, ethnicity, socioeconomic status, education level, or geographic region—have increased markedly.”
Before solutions can be created, the root problems need to be addressed. One of the factors contributing to increased incidence of obesity is our unhealthy dietary habits (myself included). A chart from the New York Times highlights the economic impact of our food choices has been impacted by inflation trends. Over the last 30 years, unhealthy foods (beer, butter, and soda) have become much cheaper than healthy foods (fresh fruits and vegetables), on a relative basis (see chart below). Making a trip to fast food chains has not only become more convenient, but the practice has also become more affordable.
Source: Bureau of Labor Statistics (NY Times)
With our work lives stretched even further and stress levels rising, the picture below highlights the relationship between obesity (as measured by the Body Mass Index) and minutes spent per day eating. Our unhealthy, indoor, sedentary lifestyles take away from our healthy eating habits as well. The U.S. is the country with the highest percentage of individuals who are obese and the country that spends the third fewest minutes per day eating (eating more fast food). Seems like a fairly tight correlation.
Data Source: OECD (Organization for Economic Cooperation and Development)
Solutions?
Education / Government: Educational support through cooperation with the government is necessary to spread the word regarding the consequences of obesity. Incentives also need to be integrated into our healthcare system so individuals can responsibly attack obesity head-on.
Behavioral Modification: Healthier diet and exercise lifestyles need to be evangelized. Implementation of economic incentives can possibly improve behavior by lowering insurance premiums in exchange for better health compliance.
Medications: Research needs to continue so innovative medications can help prevent and control obesity. Arena Pharmaceuticals (ARNA), VIVUS (VVUS), and Orexigen Therapeutics (OREX) are in the late stages in an attempt of getting their obesity drugs approved by the FDA. There is tremendous profit potential if the proper mix of efficacy and safety can be proven, however the detection of side-effects can potentially derail adoption and approval.
Surgery: Advancements have been introduced through medical technologies as well. Allergan’s (AGN) Lap-Band device is an example of an FDA approved device that effectively wraps around the stomach like a rubber-band to control excessive eating urges.
Obviously this is not an easy problem to deal with, as evidenced by the skyrocketing numbers. Many face inherent genetic hurdles in conquering diabetes, while others may have other health issues that contribute to overweight problems.
With the holidays upon us, I still plan on responsibly splurging on occasion, but I’m praying I will have the discipline to mix in some veggies and a run around the block with my eggnog and turkey leg. In the meantime, perhaps I’ll help support the economy by running to the mall and burning some holiday calories by doing some shopping!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AGN, but at time of publishing had no direct positions in ARNA, VVUS, or OREX. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Friedman Looks to Flatten Problems in Flat World
Perhaps Friedman could use Gallagher's "Sledge-O-Matic?"
Thomas Friedman, author of recent book Hot, Flat, and Crowded and New York Times columnist, combines a multi-discipline framework in analyzing some of the most complex issues facing our country, from both an economic and political perspective. Friedman’s distinctive lens he uses to assimilate the world, coupled with his exceptional ability of breaking down and articulating these thorny challenges into bite-sized stories and analogies, makes him a one-of-a-kind journalist. Whether it’s explaining the history of war through McDonald’s hamburgers, or using the Virgin Guadalupe to explain the rise of China, Friedman brings highbrow issues down to the eye-level of most Americans.
In his seminal book, The World is Flat, Friedman explains how technology has flattened the global economy to a point where U.S. workers are fighting to keep their domestic tax preparation and software engineering jobs, as new emerging middle classes from developing countries, like China and India, steal work.
The Flat World
In boiling down the recent financial crisis, Friedman used Iceland to explain the “flattening” of the globe:
“Fifteen British police departments lost all their money in Icelandic online savings accounts. Like who knew? I knew the world was flat – I didn’t know it was that flat…that Iceland would become a hedge fund with glaciers.”
The left-leaning journalist hasn’t been afraid to bounce over to the “right” when it comes to foreign affairs and certain fiscally conservative issues. For example, he initially full-heartedly supported George W. Bush’s invasion of Iraq. And on global trade, he has a stronger appreciation of the economic benefits of free trade as compared to traditionally Democratic protectionist views.
Calling All Better Citizens
In a recent Charlie Rose interview, Friedman’s patience with our country’s citizenry has worn thin – he believes government leaders cannot be relied on to solve our problems.
When it comes to the massive deficits and foreign affair issues, Friedman comes to the conclusion we need to cut expenses or raise taxes. By creating a $1 per gallon gasoline tax, Friedman sees a “win-win-win-win” solution. Not only could the country wean itself off foreign oil addiction from authoritarian governments and create scores of new jobs with E.T. (Energy Technologies), the tax could also raise money to reduce our fiscal deficit, and pay for expanded healthcare coverage.
It’s fairly clear to me that government can’t show the leadership in cutting expenses. Since cutting benefits for voters won’t get you re-elected, taxes most certainly will have to go up. Wishful thinking that a recovering economy will do the dirty, debt-cutting work is probably naïve. If forced to pick a poison, the gas tax is Friedman’s choice. I’m not so sure the energy lobby would feel the same?
Political gridlock has always been an obstacle for getting things done in Washington. Technology, scientific polling, 24/7 news cycles, and deep-pocketed lobbyists are only making it tougher for our country to deal with our difficult challenges. Regardless of whether Friedman’s gasoline tax is the silver bullet, I welcome the clear, passionate voice from somebody that understands the challenges of living in a flat world.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) owns certain exchange traded funds (BKF, FXI) and has a short position in MCD at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Turkey Day Tidbits
Well, I have managed to pull away from my turkey, mash potatoes, and pumpkin pie to scribble down some Cliff Clavin-like trivia as it relates to Thanksgiving.
Did you know?
- Origin of Thanksgiving: The genesis of Thanksgiving dates back to the fall of 1621 when only half of the pilgrims who sailed on the Mayflower survived. The survivors were thankful to be alive and therefore decided to have a thanksgiving feast. In 1863 President Abraham Lincoln declared the last Thursday of November as a national day of thanksgiving before Franklin Roosevelt (in office from 1933-1945) changed it to the fourth Thursday of the month to encourage holiday shopping (in case there was a fifth Thursday). As you can see, our infatuation with consumer spending existed all the way back to the first half of last century.
- Turkey Chasing Trivia: For a plump delicious item consumed with gravy from my plate at a leisurely pace, I was surprised to discover wild turkeys can run up to 20 miles per hour and burst into flight speeds of approximately 50-55 miles per hour in a matter of seconds. Glad my fork and knife can contain this fast fowl from escaping its destiny into my belly.
- Turkey Eating Trivia: The number of turkeys raised in the U.S. is estimated at 250 million in 2009, down about 8% from the $4.5 billion and 7.9 billion pounds produced in 2008. Minnesota, the “Gopher State,” is expected to be the top turkey producing state, registering in at 45.5 million gobblers. The annual turkey consumption of an American averaged 13.8 pounds in 2007 – with a healthy portion of that consumed during the Thanksgiving holiday period.
- Other Fixins: You can’t have Thanksgiving turkey without cranberries, which explains the 709 million pounds of production expected in 2009 (more than half coming from Wisconsin). Cranberries are considered one of three native fruits to North America (the others are Concord grapes and blueberries). There were about 3 billion pounds of sweet potatoes and pumpkins produced in 2008 (North Carolina and Illinois were the leading producers, respectively.).
- Wishbone History: Back in the days of the Etruscans (about 1200 BC–550 BC), chickens were used for fortune-telling and the dried wishbones of the dead fowl were stroked for good luck. The tradition evolved through Roman times and the wishbone practice was modified to include the breaking of the bone. Eventually the custom made it to England, and the English took it to the New World.
- Holiday Football: Ever since the league was created, the National Football League (NFL) has played games on Thanksgiving. The Detroit Lions have hosted a game every Thanksgiving Day since 1934, with the exception of World War II (1939–1944).
More than all the trivia, I enjoy this holiday as a time for contemplation. The daily rat race hits us all to some degree and can distort our views of reality. On days like today, it’s nice to suppress the craziness (albeit temporarily) to reflect on those issues important to us, thereby reshaping our lives back into proper perspective.
And oh yeah, squeezing in some football on the boob-tube and stuffing my face with pie and ice cream makes it all the more enjoyable.
A happy and healthy Thanksgiving to all,
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Turkey Stuffing, Wall Street Style
There will be no shortage of turkey stuffing this year, thanks to a story from Joshua Brown’s The Reformed Broker site (Wall Street Turkeys…Full of Stuffing).
In the spirit of Thanksgiving, which turkeys did journalist Terry Keenan roast?
Timothy Geithner: A fledgling economy and aggressive fiscal measures have painted a big target on Geithner’s back. I don’t fall into the “let’s lynch Geithner” camp, but Keenan feels “It’s a fair bet President Obama’s least-popular appointed official won’t be around to roast next Thanksgiving. “
John Thain: The former Merrill Lynch CEO and Bank of America executive who spent $1.2 million redecorating his Manhattan office made the list too. The man referred to as “I-Robot” may be difficult to cook, but regardless the article claims he is seeking to find employment running a different public company in the mean time.
Larry Summers: As the Director of President Obama’s National Economic Council, Mr. Summers has done a respectable job of flying below the radar, but not low enough to escape his past as Harvard University’s President (and the associate poor performing endowment).
Jeffrey Immelt: GE is no weakling, weighing in around $170 billion in market cap, but Keenan highlights the fledgling performance of NBC over the last two decades as reason to stuff this turkey.
Vikrim Pandit: The CEO of Citigroup survived a tumultuous period in 2009. Keenan however underscores how:
“His image suffered a big blow at the hands of Andrew Ross Sorkin, who paints an unflattering portrait of Pandit in his best-selling book, Too Big to Fail. If Pandit can’t play the “source game” to his advantage, it’s hard to see how he’s up to the much tougher task of reviving Citi’s fortunes.”
Now that we’re done with the turkey, could you please pass the stuffing.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and its clients own certain exchange traded funds (including VFH), but currently have no direct positions in BAC, GE, or C. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Equities Up, But Investors Queasy
The market may have recovered partially from its illness over the last two years, but investors are still queasy when it comes to equities. The market is up by more than +60% since the March 2009 lows despite the unemployment rate continuing to tick higher, reaching 10.2% in October. Even though equity markets have rebounded, recovering investors have flocked to the drug store with their prescriptions for bonds. Mark Dodson, CFA, from Hays Advisory published a telling chart that highlights the extreme aversion savers have shown towards stocks.
Source: Hays Advisory LLC (Thomson Reuters Datastream)
Dodson adds:
“Net new fund mutual fund flows favor bonds over stocks dramatically, so much so that flows are on the cusp of breaking into record territory, with the previous record occurring back in the doldrums of the 2002 bear market. Given nothing but the chart (above), we would never in a million years guess that the stock market has rallied 50-60% off the March lows. It looks more like what you would see right in the throes of a nasty stock market decline.”
Checking and savings data from the Federal Reserve Bank of Saint Louis further corroborates the mood of the general public as the nausea of the last two years has yet to wear off. The mountains of cash on the sidelines have the potential of fueling further gains under the right conditions (see also Dry Powder Piled High story).
As Dodson notes in the Hays Advisory note, not everything is doom and gloom when it comes to stocks. For one, insider purchases according to the Emergent Financial Gambill Ratio is the highest since the recent bear market came to a halt. This trend is important, because as Peter Lynch emphasizes, “There are many reasons insiders sell shares but only one reason they buy, they feel the price is going up.”
What’s more, the yield curve is the steepest it has been in the last 25 years. This opposing signal should provide comfort to those blue investors that cried through inverted yield curves (T-Bill yields higher than 10-Year Notes) that preceded the recessions of 2000 and 2008.
Equity investors are still feeling ill, but time will tell if a dose of bond selling and a prescription for “cash-into-stocks” will make the queasy patient feel better?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Meredith Whitney’s Cloudy Crystal Ball
Meredith Whitney, prominent banking analyst at her self-named advisory group, should have worn a bib to protect her from the adoring drool supplied by Maria Bartiromo in a recent CNBC interview. Ms. Whitney has quickly become a banking rock star during this “Great Recession” period. She was right at a critical juncture, and as a result she was thrust into the limelight. Much like Abby Joseph Cohen, the perma-bull Goldman Sachs strategist who gained notoriety in the late 1990s, Whitney (the perma-banking bear) will continue having difficulty living up to the lofty expectations demanded of her.
Despite the accolades, Whitney’s crystal ball has gotten cloudy in 2009. I suppose accuracy is not very important, judging by her bottom-half 2007 ranking (year of her major Citigroup call) in recommendation performance and 48%-ile ranking in the first half of 2008. Analysts, much like reporters, can avoid looking dumb by reporting the news du jour and by following the herd. Whitney has followed this formula with her continuous bearishness on the financial sector, excluding a brief but late upgrade of Goldman Sachs in July. Not only was her analysis tardy (Goldman’s stock tripled from the 2009 bottom), but her call has also underperformed the S&P 500 index since the upgrade.
Incoherent Inconsistencies
Like a bobbing and weaving wrestler (her husband John Layfield is a retired staged professional wrestler from the WWE), Whitney tries to concoct a completely mind-boggling narrative to explain her forecasts this year in the CNBC interview with Maria Bartiromo:
11/18/09 (XLF Price $14.60): “For the year, I have been at least ‘cover your shorts, go long.’ I haven’t been this bearish in a year.” (See Maria Bartiromo Interview)
Hmm, really? Are you kidding me? Wait a second…is this the same “go long” Meredith Whitney that expressed the following?
3/17/09: (XLF: 8.55 then, 14.60 now +71% ex-dividends): “These big banks are sitting on loans that were underwritten with bad math, and the stocks are going to go down…these stocks are uninvestable.”
(Fast forward to minute 8:20 for quote above)
2/4/09 (XLF: 8.97 then, 14.60 now +63% ex-dividends): “Investors should not even consider owning banks on an equity basis” (Click here and fast forward to minute 8:10 for quote).
The schizophrenic accounting of her postures are all the more confusing given her stance that the sector was “fairly valued” in October, according to the CNBC Bartiromo interview.
Don’t get me wrong, she made an incredible bearish call on Citigroup in the fall of 2007 and was expecting blood in the streets until a massive rebound in 2009 surprised her. Investors need to be wary of prognosticators that get thrust into the limelight (see Peter Schiff article) for a single prediction. The law of large numbers virtually guarantees a new breed of extreme forecasters will be rotated into the spotlight any time there is a major shift in the market direction. I choose to follow the footsteps of Warren Buffett and stay away from the game of market timing and market forecasts. I believe James Grant from the Interest Rate Observer states it best:
“The very best investors don’t even try to forecast the future. Rather, they seize such opportunities as the present affords them.”
Meredith Whitney may be a bright banking analyst and perhaps she’ll ultimately be proven right regarding the downward banking stock price trajectories, but like all bold forecasters she must live by the crystal ball, and die by the crystal ball.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and its clients own certain exchange traded funds (including VFH), but currently have no direct positions in C, GS, or XLF. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
A Rare Breed: Father of Growth Investing
The man, the myth, the legend.
Successful long-term growth managers are part of a rare breed, but Thomas Rowe Price, Jr. – also known as the “Father of Growth Investing” – certainly qualifies. Too often, value legends like Warren Buffett and Benjamin Graham are highlighted in media circles. Using a baseball analogy, growth heroes like Mr. Price are more akin to atypical knuckleball pitchers, like Hall of Famer Phil Neikro. Writing about Mr. Price is consistent with my belief that investors striving to improve performance will be served well by studying great investors (for other growth superstars, see also Phil Fisher, Ron Baron, and John Calamos, Sr.).
History
T. Rowe Price was born in Linwood, Maryland, in 1898 and died in 1983. Price graduated from Swathmore College in 1919 with a degree in Chemistry, and then went onto work at Baltimore-based Mackubin Goodrich, which eventually became Legg Mason Inc. (LM). In 1937 he founded T. Rowe Price Associates (TROW) and successfully ramped up the company before the launch of the T. Rowe Price Growth Stock Fund in 1950. Expansion ensued until he made a timely sale of his company in the late 1960s (fortuitously before the 1973-1974 crash).
Philosophy
How did Price feel about growth investing?
“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”
This philosophy makes perfect sense to me; however it runs contrary to the strategies implemented by many managers whom are categorized in the “growth” style box today. In the hyper-sensitive, short-term focused performance world, many “momentum” managers play in this same “growth” sandbox. Typically this means managers buy stocks that are going up and sell stocks that are going down (see “momentum” article) over relatively short time frames, on average.
Price also firmly believed in fundamental research. As part of the investment process, Price believed in the “Life Cycle Theory of Companies,” meaning companies followed the phases of a human (birth, maturity, and decline). Price expands on this idea by stating the following: “An understanding of the life cycle of earnings growth and judgment in appraising future earnings trends are essential to investing.” He placed emphasis on investing in quality companies in good times and bad. In order to strip out economic cycle impacts, he compared company performance to peer performance – regardless of macroeconomic conditions.
John Train, the writer of “The Money Masters,” maintained the following factors were key underpinnings of Price’s investments:
- Superior research to develop products and markets.
- A lack of cutthroat competition.
- A comparative immunity from government regulation.
- Low total labor costs, but well-paid employees.
- At least a 10% return on invested capital, sustained high profit margins, and a superior growth of earnings per share.
Buy and Hold
The proof was in the pudding when it came to the “patience” referenced in Price’s quote above. For example, in the early 1970s, Price had accumulated gains of +6,184% in Xerox (XRX), which he held for 12 years, and gains of +23,666% in Merck (MRK), which he held for 31 years (Lessons from the Legends of Wall Street, Nikki Ross). Timing was not the most important factor in pulling the decision trigger:
“It is better to be early than too late in recognizing the passing of one era, the waning of old investment favorites and the advent of a new era affording new opportunities for the investor.”
In the polluted world of mass information that we sift through every day, I recommend reviewing the strategies of greats, including the “Father of Growth Investing” (T. Rowe Price). That’s my fatherly advice for you.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and its clients owns certain exchange traded funds, but currently have no direct position in LM, TROW, XRX or MRK. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Secure Your GPS (Global Portfolio Specialist)
We’ve all been there, our head in our hands, lost in the middle of nowhere. One reason for blame can be overconfidence in the directions provided or our map reading abilities. Now we have GPS (Global Positioning System) devices – a tool I now could never live without. In the investment world, with the damage that has been done, intelligent advice is needed more than ever. Unfortunately, there is no GPS device to guide our investments, but many individuals would do their self a favor by finding the right experienced professional advisor to act as your GPS device (Global Portfolio Specialist).
Getting from point A to point B in the real world can be quite simple. In the investment world, the roadways are constantly shifting. Changes in interest rates, tax policies, unemployment, fiscal initiatives can represent obstacles, the equivalent of road construction barriers, potholes, erosion, mudslides, and earthquakes in our quest for financial freedom. Navigating these winding paths can require a GPS advice. Asking for help or directions can be embarrassing and castigating for some, especially for some proud males. Stubbornly appearing to have the answer can be more important for some, and can cloud the decision making process – even if assistance can lead to the most efficient path to prosperity.
Having a guide at your fingertips as you meet unknown forks in the road is a nice asset to have. Unfortunately finding the right guide is much easier said than done, many guides can have ulterior motives and hidden agendas that conflict with yours. So although, having a guide may be ideal, finding the right guide requires a lot of research (read how to find an advisor). The scope of qualifications between the capabilities of one advisor compared to another can be like comparing a plastic butter knife with a stainless steel swiss-army knife. The cheap butter knife may handle a few simple needs, but most investors would be better served by someone with a breadth of tools that can assist you with a diverse set of circumstances.
The old cliché states men hate to get directions while women seek a security blanket (a plan). GPS is not full proof, as occasionally the software is not updated or gets confused. But tech geeks like me have grown to love the assistance and benefit from the heightened efficiency and safety it provides. Not only am I more confident, but it also gets me to where I want to go in less time.
Having your guide is important when it comes to investments, but having someone with expertise in tax planning (should I consider Roth conversion in 2010?); estate planning (what impact will the expected changes in the estate tax rate have on my future?); and insurance planning (do I have adequate life, health, and business insurance?) can be critical. All these areas can have a profound impact on whether you achieve your personal and financial goals.
Along the road of life, there can be many bumps, twists and turns. If you would like the assistance of a professional advisor, consider doing your homework and finding the appropriate GPS. Here is a checklist:
1) Where are You Now? This means taking inventory of your assets and liabilities, getting a handle on your income and expenses, and having a firm understanding of your tax and family planning issues (will, trust, powers of attorneys, etc.)
2) Where are You Going? Next you need to know where you want to go? You may have a rough idea, but in order to create a coherent plan, goals need to be defined.
3) Create a Plan. Everyone’s map or blueprint will look different. Some will need highly detailed directions, while others due to different circumstances may have less complex needs or shorter distances to travel. Some may need guidance and directions to reach an adjacent state, while others may have more ambitious goals or planning needed to reach the peak of Mount Everest. Different destinations and circumstances will require different planning.
4) Monitor and Adjust Plan as Necessary. Road conditions, weather, breakdowns, flight cancellations, among many other unforeseen circumstances can change the path to your goal. That’s why it’s so important to review, not only the changes in external circumstances, such as the financial markets, but also any individual changes whether it’s health, family, personal, or goal related.
Some people prefer to do things the old-fashion way or are happy with subpar technology (i.e., compass). However, if you do not want to get lost, or want a clearer defined map, then it’s time to shop for that new Global Portfolio Specialist who can help guide you to your destination.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) or its clients owns certain exchange traded funds, but currently has no direct position in GRMN. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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